Finadium report: Transforming the Agency Lending Business Model

A new report from Finadium takes a fresh look at the securities lending agent business model and finds three scenarios for future evolution. Agent lenders for beneficial owners, including pension plans and fund complexes, have built robust businesses based on their deep experience in the financing markets and relationships with counterparties. A regulatory, technological and operational infrastructure now exists around agency lending that was hard to image twenty years ago. Even so, securities lending is in the middle of substantial change. In order to remain successful franchises, agent lenders must evolve to meet market demands. Financial markets are built on innovation and agency securities lending is no exception.

This report is a fresh look at the agency lending business model and an examination of three scenarios for its evolution. The scenarios are based on several market assumptions: a decreased demand for general collateral; the emergence but not market takeover of central clearing in securities lending; and continued regulation that brings increasing transparency to securities lending and related transactions. There is no scenario in which the need for securities finance transactions disappears; the vital questions are what shape does this need take and how is the need met.

The major new change coming to lending is that the cost of doing business is rising due to regulation for both lenders and borrowers. If general collateral (GC) loans are currently made at 11 bps, the same loan with the full cost of indemnification included may be closer to 21 bps. Will prime brokers pay 21 bps for the same loan they get for 11 bps today? They will pass these costs on to hedge funds with an incremental mark up. Will hedge funds pay 29 bps for a trade they do today at 19 bps? While a 10 bps difference may seem trivial, the answer depends on the fund. An activist fund betting on a multi-percentage stock price movement may not care. A fund trading for earnings of only 20 or 30 basis points will be deeply affected. Indications so far are that securities loans may not be the most efficient channel for hedge funds to meet their need for downside economic exposure.

This report is not a review of securities lendingʼs challenges but rather a look at its future. Our starting point is that securities lending does face obstacles, but market participants boast strong global franchises and substantial financial markets expertise. Its greatest difficulties are competition from other products that may offer cheaper or easier access for end-consumers. The demand for securities financing and short market exposure will exist long into the future. The question is not whether there is a need for securities financing, but rather in what ways is securities lending the most efficient means of meeting that need.

This report has been written for agent lenders, their beneficial owner clients and regulators looking at the evolution of the important market function of securities lending. For agent lenders, the report offers ideas for how internal organizations may adapt their business units to suit emerging market needs and regulatory requirements.

Beneficial owners may better understand the current dynamics of their agent lender partners and how they may expect their own business arrangements to change. The report may also encourage beneficial owners to consider proactive updates to their own lending programs in expectation of future market changes.

Regulators looking at securities lending will gain insights to how lending may evolve over the next two years, with implications for how regulations are considered going forward.

For more information on this report and to read the Table of Contents, please visit the Finadium website.

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